Brexit? What Brexit?

24th August 2016

Rowan Dartington Signature’s Guy Stephens on whether Brexit gloom is all talk with very little substance

We are now two months from the Brexit vote and the doomsters are beginning to sound like an outdated stuck record. Last week saw some key UK economic statistics which continue to reveal a robust economy. UK retail sales rose by 1.4% in July on a month-on-month basis compared to forecasts of an increase of between 0.1% and 0.2%. Stripping out fuel, retail sales were 1.5% higher. On an annual basis, retail sales are almost 6% higher from last July – so much for forecasters and Brexit pessimism! The analysis suggested this was down to the weak pound attracting tourist spending and the sunshine. However, this would have required a significant degree of last minute holiday bookings in the last week of June but clearly the UK is currently relatively good value as a tourist destination.

Readers may also recall the first estimate of second quarter GDP which was released on 27 July which also surprised at .6% compared to forecasts of 0.4%. However, this is the first estimate and only includes data from the first six weeks of the quarter but, even so, everyone knew the Brexit vote was coming and there were extensive reports of delays in business investment spending. The next estimate is released on Friday this week which will include data for the full quarter which will be interesting to dissect and will add more granular detail to the debate.

Contrasting these two reasons to be cheerful with the Purchasing Managers Indices gives a confused picture of contradiction. The latter have all plunged following the results of this survey of key managers within the business community. However, it is a sentiment indicator and not a measurement of actual demand and is therefore prone to human behavioural bias. We are all being told by the media that we should be worried about the economic consequences of the Brexit vote and so many people are holding their breath, possibly postponing investment decisions, and are understandably cautious.

The Bank of England has also waded in and surprised many by the size of its stimulus package. Mark Carney had dished out large doses of gloom ahead of the vote and so had to follow through to some degree for the sake of credibility. Note the fate that befell George Osborne who abandoned his so-called emergency tax rises and fell on his sword as he was exposed as a key contributor to the fear campaign. It was he that recruited Mr Carney and it is usually a wise career choice to support your boss when he appears to need it! Some commentators are now saying that the Bank of England has shot its bolt and has been too aggressive too early. If UK economic growth subsequently slows sharply into the autumn of this year, there is very little ammunition left in the interest rate and quantitative easing armoury.

Meanwhile, the equity and bond markets are hovering around highs whilst many of the key decision-makers are on the beach. It is probably very likely that if the Brexit slowdown proves illusory then Janet Yellen will resume her programme of interest rate rises as the level of US economic growth, although hardly stellar, is incompatible with such a low level of interest rates. One surprising statistic is the level of market volatility which remains at lows and that suggests either a very relaxed and confident investment environment or one of complacency. If it is the latter, then this rarely lasts as it is inevitable that an unexpected event will appear and cause investors to rue that complacency.

In terms of investment strategy, it is difficult to advocate a high allocation to cash or short-dated sovereign debt due to the low returns available and, in the case of the latter, the valuation. The Brexit negotiation is unlikely to even start until well into next year, assuming we wait for the French (May) and German (August) elections, which looks increasingly likely. Sterling is therefore likely to remain weak and this would suggest that overseas earnings will continue to be more attractive than domestic which could be vulnerable to a lack of investment clarity and then potentially a poor outcome when the negotiations eventually get under way. It already seems unlikely that the City’s EU passporting arrangements can be preserved which is keeping any recovery in financials at bay and having a knock-on influence on perceived demand for City office accommodation.

We are therefore taking profits in UK equity holdings which have performed strongly post-Brexit and recycling this into additional overseas exposure. One area which appears to offer value is Emerging Markets, boosted by some noises surrounding an oil supply agreement between the Saudis and Russia. We have been here before and any significant move up from here in the oil price will bring the fracking industry back to life, so we don’t foresee a strong recovery. Commodities appear to have bottomed but demand is unlikely to recover soon whilst China slows. However, the valuations are relatively attractive and the region has been off the radar for many for the last three years – we are therefore selectively adding where appropriate.

I heard a Brexit analogy to the Y2K technology disaster last week – all talk with little substance. It is too early to say at the moment but so far, the UK economy is holding up very well.